“As LIBOR rises, hybrid ARM borrowers become exposed to payment shock at their interest rate reset. For example, at the recent peak in mid-October, the rate adjustment could have caused subprime borrower payments to increase by 30-50 percent, particularly for loans with deeply teased initial rates,” said managing director Roelof Slump. “While LIBOR has been trending lower from its recent highs, it continues to be of concern, as it directly impacts borrower affordability, and ultimately collateral and bond performance.”
In an interesting twist, however, Fitch said that this time around it believes servicers have the tools and programs in place to mitigate rate shock and subsequent borrower defaults. In other words, borrowers that survived the first round of resets may be better able to find a loss mitigation option before the axe swings on a subsequent reset.
Much of financial press has in the past year focused a great deal of attention on the issue of subprime ARM resets — and while problematic, the peak of ARM resets came with LIBOR rates near historical lows, which lessened rate shock for affected borrowers and helped avoid making things worse. But what most have missed is that many borrowers will see rates continually adjust, often every six months after the initial rate reset has been hit.
Of the outstanding $418 billion of subprime ARM loans, Fitch estimated that a total of 1.8 million loans, or $347 billion in outstanding principal balance, are on average approximately half a year away from either their initial or next rate reset date.
The vast majority of that total — 1.4 million loans, totaling $245 billion of the total outstanding subprime ARMs — are already past their initial rate reset, Fitch said. Based on recent peak LIBOR rates, borrowers surviving the first rate reset would have seen increases from their initial rate of 8.80 percent to 9.96 percent, which would cause their payments to increase further by an average of $153, or 10.7 percent.
Fitch analyts said that servicers have picked up the pace of loan modifications for subprime borrowers, citing HOPE NOW data, and suggested that if the loan workout level continues at the pace evidenced in 2008, over 1 million of the 1.8 million estimated subprime borrowers at risk should find some relief over the next six months.
“Modification programs have increasingly been made available to borrowers who can’t afford the higher payments in order to help them stay in their home as it may be the only alternative to foreclosure,” said Suzanne Mistretta, a senior director at the rating agency.
For all that Fitch said about the prospects for at-risk subprime borrowers, it’s worth noting what wasn’t said: many Alt-A and option ARM borrowers (read: mostly prime credit risks) face similar recast risks, but the same HOPE NOW data used to drive optimism from the rating agency suggests that prospects for prime borrowers are far more grim than their subprime counterparts.